IN the world of investment, it is not uncommon to hear cases of investors suffering the loss of their entire capital, in what is perceived as a blink of an eye.
In reality, this is rarely the case. More often than not, adequate warning signals have foreshadowed such outcomes – it boils down to whether or not investors choose to recognise these signs.
I recall a client of mine, Jake (not his real name) whom I met a few years ago. Jake had a large sum of money invested in a unit trust fund, which after some research, I discovered was not doing very well.
In the four years since he had invested a capital of RM200,000, Jake had already lost 30% of his investment, which totalled around RM60,000. At the same time, I discovered there was another fund in the same category that had gained 24% in the same period. Between the two funds, there was a gap of 54% in the return difference.
In the field of financial advisory, this represents a huge red flag. The client had already lost a third of his money in a fund that had proved from Day One to be nothing but a sinking ship.
My advice to Jake was this: Withdraw what was currently remaining of his unit trust fund at a loss, and invest it into a comparable fund that was performing better.
However, even after presenting the facts and figures, Jake refused to take any action. His decision was to wait for the fund to rebound or improve before selling his unit trust investment.
Another three years passed, his unit trust performance didn’t get worse but is at around 30% loss after seven years of investing. Another performing fund has continued to do well, giving a gain of 60% of return over the seven years.
Why investments fail
Jake’s case is not unique. There are many others out there like him, who make the same decisions, only to end up suffering more losses with time.
The problem lies in the popular misconception that the act of investing is all about driving your capital to maximise your monetary gains. While this may be your ultimate goal, it only describes one half of the art involved when it comes to investing.
To invest successfully, you will need to drive your money to achieve the best gains possible while minimising your risk. This means, one must not only focus on investing money for gain, but also focus on cutting or minimising losses when your investment starts to fail.
To quote world-famous real-estate investor, Donald Trump: “Part of being a winner is knowing when enough is enough. Sometimes you have to give up the fight and walk away, and move on to something that’s more productive.”
Many are savvy and knowledgeable when it comes to buying, but few know when to sell or are in denial to do so. There are several reasons for this:
• Lack of monitoring: Buying into an investment is just the beginning of the money optimisation journey. Many fail to regularly monitor and review how their unit trust or shares are doing, thus leaving them unaware as to when the investments start underperforming.
l Paper loss: The reality of the losses incurred is taken lightly. Many fail to cut their loss and move on because they feel that paper loss is not an actual loss. As long as they do not perform the transaction to realise their losses, it is not final that it is a failed investment. They can still take comfort in the hope that the investment will eventually profit over time. Investors focus primarily on the capital they would lose if they sell, instead of focusing on the cost of not moving on.
lTheir hope for a turnaround: Chance is a vital ingredient in the investing game. Many think they have figured the market out, and refuse to accept the warning signs that prevail. They believe that if the market has dropped, it can and will rebound eventually.
Knowing when to make the cut
“Rule #1: Don’t lose money. Rule #2: Don’t forget Rule #1.” – Warren Buffett
Easier said than done for sure, knowing when to cut your losses is a crucial part of investment.
In Jake’s case, selling his unit trust fund at a 30% loss may have seemed painful at the time. However, maintaining his irrational decision even after a four-year downward trend cost him not only RM60,000, but also the chance of capitalising on another better-performing fund with returns of 60%.
And so, the first step to minimising your losses is to monitor your investments, and recognise the warning signals when you see them. Here are some ways for you to know if it is time to cut the cord to your current investments:
1 Monitor your gains and losses. Perhaps one of the most obvious and straightforward pointers is to monitor the results of your investments at least annually. Get information on the performance of your investments from newspapers, financial magazines, and other reliable sources. If you find that your investments are making losses continuously for two to three years, it is time to gather your funds and leave, even if you have to sell them at cost or below cost value.
2 Apple to apple comparisons. Even if you determine that you are making gains, it is wise to compare your current investment to peers in the market. If you had invested in a China Equity fund, make comparisons to other China Equity funds too. If you find that yours is less profitable, then it is time to make the cut and choose the better alternative.
3 Be rational, not emotional. There is one rule I’d like you to remember here: Past performance of your investment does not guarantee future performance of your investment. If your investment begins to drop in value, waiting further will not guarantee a comeback. At the same time, if your investment begins to grow, this still does not ensure that it would continue growing. So, make your decision to cut your losses wisely based on your objective and rational assessment of the situation.
Succeeding in money optimisation is not just defined by increasing one’s investment gain, but also by reducing one’s investment losses. When you fail to cut your losses and move on to the next sailing ship, you then miss out on the opportunity you may have had to optimise your money further.
Remember, making losses does not define your failure – everyone makes losses once in a while. What’s important is that you keep them to a minimum, move on, and learn from it. Do not allow your emotions to take over and cling on to any false hope. Big losses start from small losses, and as long as you are able to identify a sinking ship when you see one, you are equipped for the long and fruitful journey of investment.
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